Paying attention to inattention

by Olivier Coibion and Yuriy Gorodnichenko

Vox
August 24, 2012

Economics and economists have taken a beating in the last few years. One practice on the receiving end of much criticism has been the use of models that assume rational expectations when individuals are well informed. This column proposes some tests of these assumptions and argues that 'imperfect information' models may succeed where others have failed.

It should be clear that among the causes of the recent financial crisis was an unjustified faith in rational expectations ...

Paul Volcker, 27 October 2011

Macroeconomics has taken a public flogging since the onset of the financial crisis, both from those outside the profession (such as the Oscar-winning documentary Inside Job) as well as from some insiders (such as Krugman’s Dark Age of Macroeconomics). One prevalent criticism is the assumption of full-information rational expectations (FIRE) under which economic agents know the structure and parameters of the economic model, observe all shocks and variables in real time, and form identical expectations. And while the FIRE assumption is indeed common in macroeconomic models, macroeconomists have long been exploring departures from full information. Lucas (1972) and Kydland and Prescott (1982) are early examples of models in which agents face imperfect information, and both Tom Sargent and Chris Sims – the two most recent Nobel recipients in economics – have done groundbreaking work along these lines.

Attention to models of inattention has been particularly high over the last decade since the pioneering work of Mankiw and Reis (2002), Sims (2003) and Woodford (2001). Each propose models that embed face information rigidities – frictions which lead rational agents to have only imperfect information about economic conditions – thereby departing from the full-information component of FIRE. The recent survey of this literature by Mankiw and Reis (2011) documents that models of imperfect information can address a number of puzzles in macroeconomics, international economics and finance.

At the same time, empirical evidence on the nature of the expectations formation process has been limited. While there is a long literature testing the FIRE assumption, it has proven difficult to quantify the economic significance (for example, does a departure make a difference for the macroeconomy?) and to interpret the nature of the rejections (for example, is it irrationality or imperfect information?). In recent work (Coibion and Gorodnichenko 2011, 2012), we propose and apply new empirical tests – derived directly from theoretical models of imperfect information – that shed new light on the expectations formation process of economic agents by addressing both limitations of traditional tests.

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Income Inequality Enrages Monkey

Dr. Frans B. M. de Waal

by Brian Fung

Atlantic
August 21, 2012

Many humans have highly developed senses of fairness and morality. Some monkeys may not be far behind. Watch as one gets cucumbers and the other gets delicious, delicious grapes.

Recent research shows that although economic gains make us happier over the short term, money still can't buy happiness in the long run. What may be more important is how deep your neighbor's pockets are: Income inequality tends to make us more unhappy and less trustful, and in the short term can lead to explosions of anger and resentment.

Many humans have highly developed senses of fairness and morality, and it seems monkeys aren't far behind. Alex Tabarrok highlights research by Emory University psychologist Dr. Frans B.M. de Waal, who studied how monkeys and other mammals share many of our social mores. The reaction to unequal pay is (ahem) priceless.

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Red States, Blue States, Gray Matter

by Tom Jacobs

Pacific Standard
August 10, 2012

Ever wonder why your stance on such hot-button issues as immigration or gay marriage feels so self-evident, while someone else finds the opposite opinion so obviously correct? There are various reasons for this, but researchers have just documented a startlingly basic one:

Your brain is different from his brain.

A research team led by Gary Lewis, a postdoctoral research fellow at the University of California, Santa Barbara’s Sage Center for the Study of the Mind, has found structural differences between the brains of individuals who have different moral values.

We’re not just talking about differences in the way the brains function. Rather, they have documented significant variations in the actual volume of gray matter. That’s a big deal, and it “suggests a biological basis for moral sentiment,” Lewis and his colleagues write in the Journal of Cognitive Neuroscience.

“This does not explain political attitudes, but it improves our explanation of political attitudes,” said New York University psychologist Jonathan Haidt, who developed the framework of moral attitudes used by Lewis and his team, but did not participate in the study. “Slight differences in brain structure and function make people more prone to develop one ideology or another.

“Having these pictures will make it easier for people to believe that, when we look at questions like taxes or gay marriage or work-to-welfare rules, we’re not perceiving the same reality.”

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See also

Images of specific regions of the brain show differences between people with different moral values, especially on issues related to purity (center right), and in-group loyalty (lower right). (Courtesy Gary Lewis)

Why the Dismal Science Deserves Federal Funding

by Gary S. Becker and James J. Heckman

Wall Street Journal
August 10, 2012

The federal deficit has ballooned in recent years, and even larger deficits are coming due to the expected growth of entitlement spending. There is little disagreement among members of both political parties that federal spending should be reduced. In such an environment it is crucial that the right criteria guide the cuts that will be made. Across-the-board cuts are not a thoughtful way to make choices.

The guiding principle is basic and obvious: We should cut federal government activities that can be performed at least as well by the private sector, and maintain, or even increase, productive federal activities that the private sector alone cannot handle effectively. There is legitimate disagreement about which activities belong in which category, but the great majority of economists have long agreed that the federal government should have an important role in the sponsorship of basic research. For-profit companies have weak incentives to invest in basic research partly because the results are not patentable, and partly because the culture of basic researchers, and the journals they publish in, makes the results of basic research available to all.

For these reasons the U.S. government has long played a leading role in supporting research in physics, chemistry, biology and medicine, and to a smaller extent in economics and other social sciences. It has also played a leading role in creating objective databases on which to make wise policy. This research and data have paid great dividends in helping to provide a better understanding of DNA, genetics and the human genome, and many other phenomena crucial to the modern world.

Indeed, the remarkable growth in life expectancy in the developed world in the past 60 years has been the result of the combined efforts of federally supported basic researchers at universities and elsewhere, and applied researchers in for-profit drug and biotech companies, and nonprofit institutes.

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The Bad History Behind ‘You Didn’t Build That’

by Virginia Postrel

Bloomberg
August 3, 2012

The controversy surrounding President Barack Obama’s admonishment that “if you’ve got a business -- you didn’t build that. Somebody else made that happen” has defied the usual election-year pattern.

Normally a political faux pas lasts little more than a news cycle. People hear the story, decide what they think, and quickly move on to the next brouhaha, following what the journalist Mickey Kaus calls the Feiler Faster Thesis. A gaffe that might have ruined a candidate 20 years ago is now forgotten within days.

Three weeks later, Obama’s comment is still a big deal.

Although his supporters pooh-pooh the controversy, claiming the statement has been taken out of context and that he was referring only to public infrastructure, the full video isn’t reassuring. Whatever the meaning of “that” was, the president on the whole was clearly trying to take business owners down a peg. He was dissing their accomplishments. As my Bloomberg View colleague Josh Barro has written, “You don’t have to make over $250,000 a year to be annoyed when the president mocks people for taking credit for their achievements.”

Hectoring Entrepreneurs

The president’s sermon struck a nerve in part because it marked a sharp departure from the traditional Democratic criticism of financiers and big corporations, instead hectoring the people who own dry cleaners and nail salons, car repair shops and restaurants -- Main Street, not Wall Street. (Obama did work in a swipe at Internet businesses.) The president didn’t simply argue for higher taxes as a measure of fiscal responsibility or egalitarian fairness. He went after bourgeois dignity.

Bourgeois Dignity is both the title of a recent book by the economic historian Deirdre N. McCloskey and, she argues, the attitude that accounts for the biggest story in economic history: the explosion of growth that took northern Europeans and eventually the world from living on about $3 a day, give or take a dollar or two (in today’s buying power), to the current global average of $30 -- and much higher in developed nations. (McCloskey’s touchstone is Norway’s $137 a day, second only to tiny Luxembourg’s.)

That change, she argues, is way too big to be explained by normal economic behavior, however rational, disciplined or efficient. Hence the book’s subtitle: “Why Economics Can’t Explain the Modern World.”

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Kids Just Wanna Be Helpful

by Tom Jacobs

Pacific Standard
August 1, 2012

There’s a school of thought that considers young children essentially pure. “All things are good as their creator made them,” wrote philosopher Jean Jacques Rousseau, “but everything degenerates in the hands of men.”

Newly published research provides some support for his supposition.

“From an early age, humans seem to have genuine concern for the welfare of others,” concludes a research team led by Robert Hepach of the Max Planck Institute for Evolutionary Anthropology.

Writing in the journal Psychological Science, he and his colleagues argue that before they are socialized into selfishness, children are intrinsically motivated to help others—and not because they wish to “take credit” for their beneficence.

But how exactly do you discover a toddler’s motivation? The researchers took a novel approach: by looking straight into his or her eyes.

They note that our pupils enlarge in response to emotionally stimulating sights, and deduced this could provide an indication of what specifically prompts kids to perk up and take notice. Are they aroused by the sight of someone in need—or, perhaps, by the realization that they could play the hero by helping?

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Romney Hasn’t Done His Homework

by Jared Diamond

New York Times
August 1, 2012

Mitt Romney's latest controversial remark, about the role of culture in explaining why some countries are rich and powerful while others are poor and weak, has attracted much comment. I was especially interested in his remark because he misrepresented my views and, in contrasting them with another scholar’s arguments, oversimplified the issue.

It is not true that my book Guns, Germs and Steel, as Mr. Romney described it in a speech in Jerusalem, “basically says the physical characteristics of the land account for the differences in the success of the people that live there. There is iron ore on the land and so forth.”

That is so different from what my book actually says that I have to doubt whether Mr. Romney read it. My focus was mostly on biological features, like plant and animal species, and among physical characteristics, the ones I mentioned were continents’ sizes and shapes and relative isolation. I said nothing about iron ore, which is so widespread that its distribution has had little effect on the different successes of different peoples. (As I learned this week, Mr. Romney also mischaracterized my book in his memoir, No Apology: Believe in America.)

That’s not the worst part. Even scholars who emphasize social rather than geographic explanations — like the Harvard economist David S. Landes, whose book The Wealth and Poverty of Nations was mentioned favorably by Mr. Romney — would find Mr. Romney’s statement that “culture makes all the difference” dangerously out of date. In fact, Mr. Landes analyzed multiple factors (including climate) in explaining why the industrial revolution first occurred in Europe and not elsewhere.

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